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Another Objection to DOL’s ESG Proposal

Posted on August 13, 2020 by -

The Department of Labor (“DOL”) is poised to significantly change its rules on how ERISA plan fiduciaries should evaluate investment opportunities. The employee benefit plan community, including the Wagner Law Group, responded to the DOL’s proposed amended rule by raising concerns that it could fundamentally affect how plan fiduciaries are expected to make investment decisions.

We pointed out that it would establish new and inconsistent standards for fiduciary consideration of environmental, social and corporate governance factors (“ESG Factors”). You can read The Wagner Law Group’s Comment Letter here.

As explained in the preamble, the Proposed Rule, published in the Federal Register on June 30, 2020, would amend the DOL’s longstanding regulation titled “Investment duties,” 29 C.F.R. §2550.404a-1, to address the emergence of ESG investment funds and the DOL’s stated concern that plan fiduciaries might be improperly considering ESG Factors in making investment decisions.

The DOL recognized that over the years its advice on fiduciary consideration of incidental or secondary effects of investments has varied; the DOL proposed sweeping changes to its regulation on investment duties to “provide clarity and certainty regarding the scope of fiduciary duties surrounding non-pecuniary issues.”

The proposed rule, however, goes beyond its stated objectives to affect how fiduciaries make all investment decisions. As explained in our Comment Letter, the proposal starts by stating that fiduciaries may only consider pecuniary factors in evaluating investment options, and then defines “pecuniary factors” narrowly, thereby excluding from consideration any factor that does not fit into the definition.

This new definition of “pecuniary factor” and the DOL’s new position that fiduciary investment decisions can only be based on defined “pecuniary factors” would be impractical in application and would be a significant departure from current law and guidance which requires fiduciaries to act solely in the interests of a plan and its participants in considering the totality of relevant circumstances.

In addition, the Proposed Rule would require fiduciaries to consider “available alternative investments” in making investment decisions, without guidance as to what this would mean, and without recognizing that the best practice of comparing investment alternatives is not universally applicable to all circumstances.

As explained in our Comment Letter, we are concerned that this standard would inject uncertainty and add additional layers of analysis to investment decision-making without necessarily improving the process or the results.

The Proposed Rule does not define ESG Factors. Nonetheless, it crafts new standards treating ESG Factors as inherently non-pecuniary, and thus unacceptable considerations, unless strict higher standards are met to demonstrate pecuniary characteristics. The proposal further creates inconsistent standards for fiduciaries considering ESG Factors in selecting investment options for self-directed individual account retirement plans.

On a parallel front, the DOL has initiated investigations around the country into employee benefit plan investments that include ESG components, seeking extensive documents and information about both investment funds and the investing employee benefit plans. This development has also caused concern. It is rare, if not unprecedented, for the DOL to engage in a national enforcement effort targeting only investments with specific characteristics while there is a pending proposed regulation on the same topic, especially a proposal that changes the existing DOL guidance on the subject.

Whether or not the DOL successfully implements the Proposed Rule, the DOL’s simultaneous investigative efforts in this arena, coupled with the Proposed Rule’s shortened 30-day comment period, signal that the DOL has honed in on exploring the influence of ESG Factors in retirement plan investing.

The Wagner Law Group submitted its Comment Letter to express our concern that adopting the Proposed Rule would make it more difficult for our clients to understand how they are expected to comply with their investment fiduciary duties.

© 2020 Wagner Law Group.

Life Insurers’ Bermuda Triangle, Part II

Posted on August 13, 2020 by -

Over the past 10 years, a new and vigorous business model has gone viral in much of the once-stodgy life insurance and annuity industry. The model encompasses three types of enterprises, all owned, in many cases, by the same financial services company, private equity firm, or holding company.

The academics, regulators, and consultants who have studied the development of this business model have a new name for it: a “liability origination” platform or “private debt origination” platform. “Liability origination” refers to the art of lending profitably to below-investment grade borrowers without getting burned.

“Asset managers, particularly private equity (PE) firms, are using the new triangular organizational structure to scale up their private debt businesses,” said a recent report by three Federal Reserve economists.

“These institutions create their organizations by acquiring a suitable existing life insurance company and then establishing an offshore captive reinsurer… Starting from virtually nothing in 2008, PE firms now control roughly 8% of U.S. life insurance industry general account assets, equivalent to more than $350 billion.”

Recent news about deal-making in the life insurance industry offers examples of this trend, though usually with little context: Voya’s sale of annuity blocks to a reinsurer, KKR’s intended acquisition of Global Atlantic Financial, and the transfer of $27.4 billion in fixed annuity assets from Jackson National to Athene. MetLife’s decision to spin off its annuity businesses as Brighthouse Financial, and Prudential Global Investment Management’s pursuit of defined benefit pension assets in the U.S. and U.K., are part of this trend as well.

In this article, the third in a series, we’ll try to describe the complex liability origination platform model. The forces driving its development—the Federal Reserve’s low interest rate policy and a decline in lending by banks to high-risk corporate borrowers—are a topic for another day. Here we’ll focus on the new model, and how it turns baby boomer savings into fuel for complex loans.

Three-part engine

The three most essential components of liability origination, usually under a single corporate umbrella, are:

  • One (or a group of) life insurance subsidiaries that acquire money by selling fixed annuities and fixed indexed annuities (FIAs), buying blocks of existing fixed annuity assets and liabilities; pursuing “pension risk transfer” deals; or borrowing funds from capital markets using unconventional debt-like instruments
  • An asset manager that, more so than a conventional life insurer investment department, knows how to originate and/or buy risky corporate loans and commercial mortgages, and bundle them into asset-backed securities, which are subsequently held by their affiliated life insurers
  • A Bermuda-based “reinsurer,” typically owned by the same holding company as the life insurers and asset manager, that allows for capital arbitrage between regulatory jurisdictions; life insurers can transfer (reinsure) blocks of fixed annuity business and reduce the amount of capital required to back the liabilities

Last February, two research reports on this model appeared. In “Capturing the Illiquidity Premium,” three analysts at the Federal Reserve Board in Washington, DC wrote:

A large number of life insurers and corporations are discarding blocks of capital-intensive long-term liabilities, such as annuities and defined benefit plans, as they struggle to find long-term assets with yields high enough to fund those liabilities. Some of the largest U.S. life insurers and private equity firms are exploiting the dislocation in the annuity markets.

These institutions redeploy the relatively stable source of long-term annuity capital to capture the illiquidity premium created by banks exiting corporate lending. Within ten years, the U.S. life insurance industry has grown into one of the largest private debt investor in the world.

In a separate report, “Liability Platform Developments,” Scott Hawkins, the insurance research director at Conning, wrote:

Since their emergence in the early 2000s, specialist insurers and reinsurers have been formed that focus on acquiring and managing insurance liabilities. By the end of 2019, there were 32 liability platforms domiciled in Bermuda, the Cayman Islands, the EU, and the United States, with the majority of the formations occurring in 2014 and later.

These platforms [fall] into two broad categories. Liability consolidation platforms, such as Monument Re, Somerset Re, or Viridium, acquire closed blocks of business from insurers who off-loaded these liabilities as they focus on their core business. These acquisitions can be through reinsurance, traditional Mergers & Acquisitions, or Part VII transfers. Liability origination platforms, such as Athene and F&G, go beyond liability consolidation and create new liabilities by selling new business.

In some cases, such as AIG and its formation of Fortitude Re, it was the desire to spin out closed blocks of business [in-force contracts] that led to the creation of a liability platform. For others, Athene being the most noticeable, the ability to have access to permanent capital led to its development of many new liability platforms. [The platforms] have focused on annuities because they have lower costs of capital than life insurance. Lower capital requirements enable investors to support more liabilities [i.e. loans], potentially generating higher profits as a result.

The humble indexed annuity

The key to these multi-billion dollar deals is, ironically, the humble individual retail fixed annuity—especially its popular variant, the fixed indexed annuity, or FIA. Simple fixed annuities are like certificates of deposit. FIAs are similar, but with a side-bet on the movement of an equity index. All offer tax-deferred growth with a guarantee against loss if held to maturity.

Fifteen years ago, FIAs were considered “Wild West” insurance products—sold by highly incentivized independent agents to older people who didn’t understand what they were buying. The pioneer, and still the top retailer, is Allianz Life. But, since the financial crisis, more insurers and distributors have built and distributed them. The assets backing in-force fixed annuities and FIAs are now worth close to $1 trillion, according to LIMRA Secure Retirement Institute.

Their stability makes them attractive sources of investable funds for private equity firms. Fixed annuities seek higher yields through longer holding periods. Purchasers invest for between three and 10 years. These “long-dated liabilities” give private equity firms and their affiliated life insurers a stable source of financing for long-term lending.

Most importantly, there’s virtually no risk that individual contract owners will suddenly want their money back until the end of the term. Athene, the most prominent private equity-owned life insurer after Allianz Life, has been the second biggest seller of FIAs in recent years.

“A life insurance company’s balance sheet is a savings mediation vehicle, and the company deploys that savings as credit into economy. Unlike a bank, a life insurer has stable long-term funding—not the short-term demands of a bank. When you have the advantage of long-time horizon, you can get creative in areas of lending where life insurers traditionally haven’t played,” Matt Armas, a portfolio manager at Goldman Sachs Asset Management, explained to RIJ in an interview.

CLOs encounters

If private equity firms find blocks of fixed annuity contracts so attractive, why do so many traditional life insurers want to get rid of theirs? The answer is falling interest rates. As rates go down, life insurers have difficulty earning enough on their new investments to cover the promises they made to fixed annuity purchasers when rates were higher.

Asset managers and private-equity firms like Guggenheim, Apollo, Goldman Sachs Asset Management, Blackstone and others were able to buy those contracts—which were tying up precious capital on the insurers’ balance sheets—at discounts. They believe they can invest the assets for higher returns than the original issuers could.

What’s their secret? A talent for “liability origination.” The asset managers at private equity-owned life insurers don’t simply buy highly rated corporate bonds off-the-rack. They buy lower-rated corporate bonds and, through the dark art of asset securitization, custom-tailor them into the relatively high-yield debt they and their customers (including their affiliated life insurers and private investors) want to own.

Among those securitizations are collateralized loan obligations or CLOs. In their latest incarnation, they are bundles of high-risk corporate loans divided (as all securitizations are) into tranches of varying risk. Owners of senior tranches get paid first, which means they’re most likely to get paid and that their tranches carry investment-grade ratings.

Senior tranches of CLOs pay higher returns than similarly rated loans. One reason for the premium, the authors of “Capturing the Illiquidity Premium” wrote, because of their illiquidity. It’s time-consuming to trade them, precisely because they are complicated, specialized and difficult for buyers to evaluate. This makes them riskier, and therefore higher yielding.

A recent white paper from Guggenheim, the global private equity firm that owns Delaware Life, defines CLOs as:

“…a type of structured credit. CLOs purchase a diverse pool of senior secured bank loans made to businesses that are rated below investment grade. The bulk of CLOs’ underlying collateral pool is comprised of first-lien senior-secured bank loans, which rank first in priority of payment in the borrower’s capital structure in the event of bankruptcy, ahead of unsecured debt. In addition to first lien bank loans, the underlying CLO portfolio may include a small allowance for second lien and unsecured debt.”

For life insurers looking for securitized debt to buy, CLOs have helped replace residential mortgage backed securities (RMBS), whose supply dropped after the 2008 financial crisis. According to the National Association of Insurance Commissioners (NAIC), “Collateralized Loan Obligations (CLOs) continue to be a growing asset class for U.S. insurers; exposure increased to about $158 billion at year-end 2019, having increased 17.5% from about $130 billion at year-end 2018.”

“The strategy is securitization, but the skill is in origination,” said Michael Siegel, a managing director at Goldman Sachs Asset Management, in an interview. “First, you’re cutting out the middleman. When I did private placement for traditional insurers, we had to look for investment-grade borrowers, focus on agent-led deals that were arranged by investment banks.”

Not to be left behind, however, large traditional life insurers have been buying or building their own sophisticated asset management teams. “The traditional life insurers are building out their infrastructures [for private debt origination], but the private equity firms were way ahead of them,” Siegel told RIJ.

Bermuda: Third leg of the triangle

The third and most mysterious aspect of the liability platforms involves captive offshore reinsurers. “Captive” means that the U.S. life insurer owns its own reinsurer. “Offshore” usually means that the reinsurer is domiciled in Bermuda, which uses a different accounting standard than the U.S. does.

U.S. life insurers can isolate blocks of fixed annuity assets and liabilities, move them to their own reinsurers in Bermuda, and get a credit—usually in the form of a line of credit from a bank—for the reduction in capital requirement. This credit “frees up,” for other asset purchases, part of the capital that, under U.S. statutory accounting rules, was dedicated to supporting the annuity guarantees.

Have the private equity companies’ ventures into the life insurance industry been healthy or not? The private equity people would say that they’ve done a lot of good by infusing capital into existing life insurers after the financial crisis, taking burdensome business off their books, and ensured that all of their policyholders get paid in full and on time.

“The private equity firms have brought about $30 billion in fresh capital into the life insurance industry, which was looking to transfer the risks of their older blocks of business. That’s a healthy evolution for the industry,” Goldman Sachs’ Armas told RIJ. (Goldman Sachs got into the insurance business as early as 2004, and eventually created Global Atlantic Financial Group in 2013, which owns a life insurer. KKR, the private equity firm, is in the process of buying Global Atlantic from Goldman Sachs.)

“One point about this new business model is that, with a growing number of retirees looking to save for retirement and turn accumulated assets into retirement income, the new capital from these players is increasing the ability of insurers to write more annuities,” said Conning’s Hawkins.

In “Capturing the Illiquidity Premium,” the authors expressed some concern about the risks embedded in the CLO tranches that life insurers are holding–which may include tranches of “combo notes.” These are CLOs built from the riskiest tranches of other CLOs.

“By holding the riskiest portions of the CLOs issued by their affiliates as well as a rapidly growing portfolio of commercial real estate loans, life insurers are vulnerable to a downturn in the credit cycle. For example, a widespread decline in the value of the loans backing the CLOs could directly wipe out the equity held by the affiliated life insurers,” they wrote.

The NAIC has issued several reports on CLOs, and has periodically assessed their riskiness in life insurer general account portfolios. “CLOs are a focus of regulatory concern, particularly as the underlying bank loans are experiencing negative rating actions as a result of the impact on certain industries from the economic disruption caused by COVID-19,” one recent report said.

But the NAIC concluded in the same report that “Since U.S. insurer exposure to CLOs is relatively small, at about 2% of total cash and invested assets as of year-end 2019, and the vast bulk of these investments are rated single A or above, we do not believe that the CLO asset class currently presents a risk to the industry as a whole.”

One life insurance industry stakeholder, who asked not to be identified by name, said that they and their peers are concerned about life insurers who own fixed annuity assets and liabilities and operate liability platforms but don’t sell annuities to the public and may have no incentive to serve their existing policyholders properly.

“Industry representatives are especially concerned about the run-off blocks of business, where the insurance company isn’t engaged in the current sale of insurance and doesn’t have the same concerns about reputation,” the source told RIJ. “That whole run-off area has been booming over last decade, and the PE companies are big players in it. Some are responsible; but their incentives are not as aligned with policyholder as someone writing business.”

© 2020 RIJ Publishing LLC. All rights reserved.

 

 

Honorable Mention

Posted on August 13, 2020 by -

Innovator launches ladder of buffered ETFs

Innovator Capital Management, LLC launched the Innovator Laddered Fund of S&P 500 Power Buffer ETFs (BUFF) on Tuesday, August 11. An “ETF of ETFs,” BUFF will invest equally in each of Innovator’s 12 monthly S&P 500 Power Buffer ETFs and rebalance semi-annually.

The underlying S&P 500 Power Buffer ETFs each seek to provide a buffer against the first 15% of losses in the S&P 500 and upside performance to a cap over a one-year outcome period; they are part of Innovator’s suite of Defined Outcome ETFs.

BUFF will seek to offer investors a managed portfolio (an ETF of ETFs) that will invest equally across all twelve monthly S&P 500 Power Buffer ETFs, providing a ladder of buffered S&P 500 exposures. The twelve underlying buffered S&P 500 exposures each have a different upside cap level and period of time until their annual reset, but share a 15% buffer against losses in the S&P 500 Index over their outcome period.

“Innovator’s intention with BUFF is to offer an ETF that can provide investors a managed approach to buffered equity investing that maintains upside growth potential by continuously participating in new upside caps as the underlying ETFs reset monthly—and which can be allocated to at any point during the year,” an Innovator release said.

“BUFF will be rebalanced semi-annually, charge 20 basis points and seeks to provide investors with a simplified, efficient solution to buffered equity investing,” the release said. “It is anticipated the ETF will provide investors with lower volatility (standard deviation), beta and drawdowns relative to the S&P 500 while capturing a measure of the capital appreciation potential of U.S. domestic large-cap stocks, the largest equity market globally by capitalization and typically the most significant allocation in most diversified portfolios.”

As an ETF of ETFs, BUFF is designed to be bought and/or sold without regard for the outcome period associated with the underlying individual ETFs. The strategy, as measured by its index (the Refinitiv Laddered Power Buffer Strategy Index) seeks to provide lower volatility (standard deviation), beta and drawdowns relative to the S&P 500.

While BUFF will invest in Innovator Defined Outcome Buffer ETFs (in an equal weighted portfolio of all twelve monthly issues of the S&P 500 Power Buffer ETFs, which have a 15% buffer against loss in the S&P 500), the fund will not be a Defined Outcome product with an upside cap and downside buffer, nor an outcome period.

BUFF will seek investment results that correspond generally (before fees and expenses) to the price and yield of the Refinitiv Innovator Laddered Power Buffer Strategy Index.

BUFF will generally invest at least 80% of its net assets (including investment borrowings) in securities comprising this Index. The Index has been developed by and is maintained and sponsored by Refinitiv/Thomson Reuters.

As announced in May, to launch BUFF, Innovator will change its existing Innovator Lunt Low Vol/High Beta Tactical ETF (LVHB), including a change to the fund’s name, ticker symbol, underlying index, investment objective, management fee and strategy at that time.

In May 2020, the Board of Trustees of the Innovator ETFs Trust II approved a reduction in the annual unitary management fee paid by shareholders to Innovator Capital Management, LLC the Fund’s investment adviser, from 0.49% of the Fund’s average daily net assets to 0.20% of the Fund’s average daily net assets. In addition to the Fund’s own fees and expenses, the Fund will pay indirectly a proportional share of the fees and expenses of the underlying ETFs in which it invests, included advisory and administration fees.

Once effective, LVHB will trade its shares under the new ticker symbol “BUFF”.

Principal continues to integrate acquired Wells Fargo plans

Principal Financial Group this week announced progress toward the integrating the Wells Fargo Institutional Retirement & Trust (IRT) business with Principal’s existing retirement plan business, despite challenges posed by COVID-19 and related market disruptions. Principal’s July 2019 acquisition of IRT is on track for completion in 2021, the company said.

“The combined organization is already delivering new and enhanced capabilities to Principal and Wells Fargo IRT customers including a digital plan on-boarding experience, the patent-pending Principal Complete Pension Solution, the Principal Milestones financial wellness program,” a Principal release said.

The new, unified retirement leadership team includes executives from Wells Fargo IRT and Principal. The company has also said it would retain locations in Charlotte, N.C.; Minneapolis/Roseville, MN.; Waco, TX; Winston-Salem, N.C.; and Manila, Philippines.

Last month, Principal secured an office space in downtown Minneapolis for occupation in 2021. Additionally, many Wells Fargo IRT employees have received job offers to transition employment to Principal effective in 2021. Principal, now a top-three recordkeeper as a result of the acquisition, has also appointed a new sales leadership team, innovated its advisor and consultant service model, and expanded its sales force as a part of the company’s customer care experience.

Principal will start on-boarding new participants in October through its Principal Real Start auto-enrollment program. More than one-third of current Principal Real Start participants are saving 10% or more and one-in-three are auto-escalating their contributions up to 10%, Principal said.

Principal closed its acquisition of certain assets of the Wells Fargo Institutional Retirement and Trust business (IRT) on July 1, 2019. During the transition period, Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company, will continue to operate and service the IRT business for the benefit of Principal, including providing recordkeeping, trustee, and/or custody services.

Employees and employers see HSAs differently

A recent survey on perceptions of health savings accounts (HSAs) by Further, a national health savings administrator, found divergence between employers and employees on how best to use HSAs.

“Employers [are] positioning them as savings tools, while employees rely on them as spending tools,” Further said in a release this week. Among the survey findings:

Today, employees depend on employers to provide competitive benefits packages that meet their health care needs. In fact, 70% of consumers said comprehensive benefits are the most important factor, or a very important factor, when accepting a job.

Similarly, employers place high value on HSAs as an employee recruitment and retention tool, with 57% and 50%,2 respectively, citing these as key objectives for offering an HSA.

When asked how HSAs are primarily utilized—as a spending or saving tool—employees and employers disagree. 65% of consumers report leveraging their HSA as a spending resource, with 23% stating they use their account equally for saving and spending.

Yet, over 66% of employers associate HSAs with savings only,2 leaving a gap in how employers are positioning these accounts compared to how employees are leveraging them. “Employees and employers are not speaking the same language when it comes to health savings accounts,” said Matt Marek, CEO of Further, in the release.

Sixty percent of employees reported having a high confidence in how to fully leverage their HSAs. Comparatively, 75% of employers say that employees have a high understanding of their HSAs.

Yet, only 51% of consumers could correctly calculate how much they would have to pay for a hospital stay based on their deductible and copay, suggesting that both employees and employers may have a false level of confidence when it comes to leveraging HSA benefits, Further reported.

Variable annuities can shine in times like these: Cerulli

The COVID-19 pandemic, converging with sudden economic uncertainty and global market volatility, present annuity providers with an opportunity to publicize the values of their products’ guarantees, according to a new report from Cerulli Associates.

“While advisors have increasingly shied away from using annuities in their client portfolios over the last decade, current market volatility is prompting them to take a second look,” according to the latest edition of Cerulli Edge—U.S. Asset and Wealth Management Edition.

“Framing annuities as a type of pension or Social Security payout (e.g., defined benefit) could be an effective tactic to explain their attributes to clients,” said Donnie Ethier, director of wealth management at Cerulli, in a release this week. “A pension/guaranteed payout is likely to be attractive to specific types of clients, such as small business owners,” the release said.

Derisking portfolios—a strategy many advisors have undertaken since 2018 to mitigate portfolio risk in response to drastic fluctuations in the equity markets—may accelerate variable annuity (VA) interest from advisors in the wake of the pandemic, Ethier said.

“Insurers are working to build in ‘risk levers’ that will enable the adjustment of benefit elements on the fly, to either enhance them or derisk, as conditions may dictate.” These “risk levers” associated with VAs are a selling point for many advisors, some of whom report to Cerulli that they can adequately explain incorporating a VA to a client by positioning it as downside protection.

The challenge for insurers is whether they can sufficiently address the chief reasons cited by advisors for not using VAs—perception of high fees (79%) and a belief that other retirement income strategies constructed by their advisory practice or their home office are more efficient (37%).

However, affluent households surveyed by Cerulli’s Retail Investor practice indicate they will likely seek guaranteed payouts and portfolio diversification in this time of market turbulence, and many annuity designs can provide these benefits.

© 2020 RIJ Publishing LLC. All rights reserved.

Markets ‘unnervingly detached from economics’: CFAs

Posted on August 6, 2020 by -

Thousands of Chartered Financial Analysts (CFAs) are calling for careful oversight of the trillions of dollars worth of stimulus money appropriated by Congress through the CARES Act that was passed in March, the CFA Institute said this week.

The institute surveyed about 8,000 of its members in July. Nearly 90% of respondents said they expect to see details on the recipient, the amount, and the terms of the distribution. “We increasingly hear the frustration that securities markets and financial analysis have become unnervingly detached from economics,” CFA Institute said in a release.

CFAs “are particularly interested in full transparency on whether any affiliate of Congress or executive branch received funding,” said a CFA Institute release. The majority of members said they approved of the stimulus while also saying that it should not be unlimited.

“The amounts, parameters, and rapid roll out of this unparalleled and open-ended stimulus have raised concerns,” the release said. “The functioning of oversight committees and transparency around the various programs that ultimately will distribute record amounts of taxpayer-funded stimulus need scrutiny. Similarly, long-term concerns surround the resulting budget deficits and the impact on capital markets.”

On 27 March 2020, the US government enacted the Coronavirus Aid, Relief, and Economic Security (CARES) Act, embarking on a multi-trillion dollar program of monetary and fiscal stimulus in response to the COVID-19-induced economic shutdown. “The level of stimulus has been broad; the program parameters were put together at warp speed; and, even as negotiations over the fourth round of stimulus continue, it is generally expected that further steps and programs may be required as the extent and duration of the pandemic impacts become more predictable,” the institute release said.

The survey was fielded to all active employed CFA Institute members residing in the United States. The survey was sent on 10 July 2020, with two reminders. The survey closed 20 July 2020. Out of the members invited to participate, 8,036 provided usable data, for a total response rate of 11 percent. Margin of error was +/- 1.03%.

© 2020 RIJ Publishing LLC.

Why Life Insurers Fly into the ‘Bermuda Triangle’

Posted on August 6, 2020 by -

Yesterday’s second quarter earnings conference call with senior executives of Athene Holding offered a window into the most significant trend in the life insurance industry over the past five years: the development of an asset management model that feeds on blocks of fixed annuity contracts.

Athene, financed by the private-equity (PE) firm Apollo Operating Group (Apollo), helped pioneer a trend that started after the Great Financial Crisis. The trend has been tantamount to turning what we knew as the “life insurance” industry into something new: the “liability origination platform” business, as a recent study by Conning described it.

In short, private equity firms are buying (mostly) fixed annuity assets from large life insurers and, by using offshore captive reinsurers, freeing up capital that they can redeploy into riskier, higher-yielding assets like collateralized loan obligations (CLOs) and commercial real estate-backed securities assets (CMBS).

The trend was trailblazed by Athene, which was created in 2013 when Apollo bought Aviva Life (assets of $56 billion) and renamed it. In 2016, Athene went public in a $1.08 billion IPO. In 2018 it added annuity assets from Voya and Lincoln Financial. This year it acquired, via a reinsurance deal, $26 billion worth of Jackson National Life fixed-rate and fixed index annuities (FIAs).

“Major life insurance groups continue to reduce their exposure to legacy in-force business and to release trapped capital and resources,” said the chairman of Resolution Re last December, when he announced his firm’s still-pending acquisition-and-reinsurance deal with Voya Financial, including the transfer of assets worth an estimated $20 billion.

The price of Athene’s stock, like the share prices of other life insurers, has not recovered as well as the overall market from the COVID19-related equity crash in March. But on yesterday’s earnings call, the Athene executives were ebullient. Athene has grown rapidly, and the executives see the potential to sell a lot more FIAs to baby boomers and the opportunity to buy many more underperforming blocks of fixed annuity business.

How much business is out there? Almost a trillion dollars’ worth. According to Todd Giesing, director of annuity research at LIMRA’s Secure Retirement Institute, in-force fixed-rate annuities have a current value of $450 million. In-force fixed indexed annuities have a current value of $505 billion. (Variable annuity assets have a current market value of $1.94 trillion, but those assets are in separate accounts and contract owners can liquidate them with relative ease; fixed annuity assets are in the insurer’s general account and are less subject to withdrawal.)

Long-dated liabilities in demand

Since 2014, according to a report this year by the consulting firm Conning, over two dozen “liability origination” or “liability consolidation” companies have been formed in the U.S. or abroad to create, acquire or reinsure blocks of fixed annuity business and “redeploy” the capital more profitably.

“We’ve been following these companies—Athene, Global Atlantic, FGL—since 2013 or 2014. We’re also following the newer companies with the same business model. Since 2015, about 30 new companies with this model have come into being. We refer to it as a liability platform,” Conning’s insurance research director Scott Hawkins told RIJ recently. [Note: The private equity firm KKR is in the process of buying Global Atlantic.]

“They’re looking to accumulate annuity or pension liabilities, because they are a form of permanent capital. That’s desirable for those owners; the money will stay with them for a long period, they can invest in asset classes without an investor suddenly deciding to redeem. They can enjoy a longer time horizon, because the liabilities are longer.” In the case of FIAs, investors may not withdraw their money for as long as 10 years.

“Yes, there has been ‘some’ reconfiguration in the industry over the past six to eight years, with private equity/asset management groups acquiring annuity insurers,” said David Paul of ALIRT, which tracks life insurance companies, in an interview. “Athene/Apollo would likely be ‘Exhibit A,’ but they aren’t the only one. To speak of it as ‘a’ reconfiguration of the life industry overstates their influence.

“These asset managers feel that they have an investment edge, in part through the acquisition of private debt or CLOs, and they believe can make better spreads than traditional insurance investment shops, thereby offering more attractive rates and/or achieving better profitability. Some have also leveraged offshore reinsurance operations for tax and capital arbitrage.”

Pros and cons of PE-led insurance

What does it mean for the investors—the baby boomers who rely on annuities for safe accumulation or guaranteed retirement income? That’s a complicated question with no definitive answer, at least not yet.

On the plus side, life insurance companies have received fresh infusions of cash. The private equity (PE) firms talk about the tens of billions of capital they have poured into “primary” life insurance companies—relieving them of books of business that they couldn’t profitably support. Indeed, in today’s earnings call, Athene CEO James Belardi called Athene a “solution provider” for other firms.

The private equity companies also talk about their ability to pass on their greater efficiency and profitability to the older Americans who own FIAs. In response to a question from one stock analyst today, Belardi said Athene’s FIAs offer participation rates that are about “10 basis points higher” than the competition.

He also attributed Athene’s 40% increase in sales in the first half of 2020—at a time when the rest of the annuity industry slumped—to Athene’s use of “bespoke indexes.” These are custom or hybrid indices created by investment banks. The vast majority of FIA assets industry-wide is in the S&P 500 Index, but only “about half of our in-force business is in the S&P 500,” Belardi said. Athene has also had success in 2020, he said, “because our competitors have pulled back.”

The PE-led firms are also providing solutions to large corporations that want to sell their defined benefit pension plans—and all the longevity risk that attaches to them–to a life insurance company, which will convert the group annuity to individual annuities. “Pension risk transfers,” a business in which Prudential Global Investment Management (PGIM) has been the leader, is another way that life insurers can obtain large blocks of money. Like FIA assets, those assets are withdrawn by retirees at a slow or predictable pace, making them ideal for funding riskier investments. The life insurer thus provides a solution to corporations by relieving them of hard-to-quantify longevity risk; the corporations don’t know how long their pensioners will live.

CLOs encounters

But some observers are wary of the wave of acquisitions of life insurers by private equity firms, and have worried about this trend since it started a decade ago. The retired Indiana University insurance professor Joseph M. Belth, for instance, warned about the risk that policyholders might suffer service lapses under the issuers’ new owners, who may have chosen not to sell new annuities or life insurance policies at all.

“Problems are to be expected when private equity firms create or acquire long-term obligations of insurance companies in an effort to earn short-term profits for the benefit of their investors,” Belth wrote on his blog two years ago, after Athene agreed to pay a $15 million fine for neglecting important services to policyholders.

Others are concerned about the safety of the assets that the PE-led firms are investing in, such as CLOs. These are the securitized bundles of loans to corporations with below investment-grade credit ratings. (The National Association of Insurance Commissioners issued a report on CLOs recently.)

After the Great Financial Crisis, banks greatly reduced that type of lending. Life insurers and their affiliate asset managers stepped in to satisfy the demand for credit from corporations already burdened by debt. Like other securitized investments, CLOs are divided into tranches. The uppermost tranche is held out to be as safe as a Treasury bond; the bottom tranche is as risky as a stock.

Life insurers typically buy the highest or second highest tranches, where they can earn higher yields than on similarly low-risk assets. CLOs comprise about 9% of Athene’s investments, Belardi said, adding that the “diversified pools of senior secured loans generated returns about 100 basis points (one percentage point) higher than comparably risky corporate bonds.

“While CLOs have volatility,” he said, “we will hold them to maturity. There’s been no principal impairment in CLOs. There have been downgrades but no defaults.” Regarding the economy, he said, “We’re not out of the woods yet.” He sees potential weakness in loans to airlines and fleet leasing companies, and strength in real estate. “We’ll be a player in commercial real estate-backed and residential real estate backed securities. We expect people to stay in their homes” despite high unemployment.

The Bermuda triangle

The use of captive (i.e., owned by the same parent as the life insurer) offshore reinsurers, many of them based in Bermuda, also troubles some observers. Bermuda uses a different accounting standard (GAAP), which doesn’t require reinsurers to hold as much reserve capital as U.S. (statutory) accounting rules do. A U.S. life insurer can create its own reinsurance company in Bermuda and then can move a block of annuity business (“reinsure” it) to that new company. This act alone frees up capital, which the life insurer can use for other purposes.

“By having a Bermuda-based reinsurer, some companies are doing indirectly what they couldn’t do if the assets and liabilities stayed with the original domestic issuer: Get a credit for having reinsurance and take hard assets out,” said Larry Rybka, CEO of Valmark Financial Group, which helps advisors monitor the products they sell.

As blocks of annuity assets and liabilities accumulate (for accounting purposes) in Bermuda, the liabilities might not be sufficiently capitalized, Rybka said. He thinks there’s a danger that, behind a complex screen of transactions between closely affiliated companies—the life insurer, asset manager, and reinsurer are frequently all part of the same publicly held or private equity company—life insurers might have an incentive to capture profits for their shareholders at the expense of their policyholders.

Rybka points to a warning expressed by Federal Reserve researchers Nathan Foley-Fisher, Nathan Heinrich and Stephane Verani in a February 2020 paper: “A widespread default or downgrade of risky corporate debt could force life insurers to assume balance sheet losses of their CLO-issuing affiliates, wiping out their equity. In a worst-case scenario, the perception of balance sheet weakness could incite liquidity-sensitive institutional investors to withdraw from those life insurers.”

Not everyone agrees with all the specifics of Rybka’s view, which reflects the complexities involved. The motive for using offshore reinsurers “seems largely to be tax relief, and not regulatory arbitrage,” said Dan Hausmann, one of ALIRT’s founders. “There may be some differences in investment requirements, but any material transaction a company does would require approval from the states they do business in then. People can’t just say, ‘Let’s move $5 billion to Bermuda.’ Domestic insurers in most cases keep legal control of policy liabilities and the assets in support of those liabilities.”

So what implication does this trend—now a decade old and evidently accelerating—have for the “retirement income” industry and its stakeholders? We’ll address that broad question in future articles. But there’s no question that we’re seeing the further evolution of life insurers into asset managers.

“The larger life insurers are gradually becoming more and more asset management focused, rather than protection focused. Some will stay on life insurance, but you hear more and more of them say, ‘We’re about managing assets,’” Conning’s Hawkins said. “The large players are becoming asset managers. That’s a trend that I’ve certainly seen over my 35 years in the business.”

© 2020 RIJ Publishing LLC. All rights reserved.

COVID-19 Will Cause a Drop in AUM: Cerulli

Posted on August 6, 2020 by -

COVID-19 and the associated economic crisis are set to cause the first decline in global asset management industry assets under management in a decade, according to Cerulli Associates’ latest report, Global Markets 2020: A Sharper View of the Asset Management Sector.

The global analytics and consulting firm expects the global asset management industry to recover and grow after 2020, fueled by increasing demand in developing countries, particularly Asia. Advances in technology and product will give global asset managers more ways to access growing investor segments.

“As the coronavirus pandemic continues to impact the global economy in the second half of 2020 and beyond, asset managers will need to find ways to keep investors in their products and prevent a widespread flight to cash,” says André Schnurrenberger, managing director, Europe at Cerulli Associates.

“Managers should dedicate resources to investor education on how to handle a market correction, implementing scenario analysis from the last significant global drawdown in 2008.” These resources will be especially useful in those countries where emerging middle-class investors have entered the market within the past decade and had not experienced a substantial correction before COVID-19.

As the global economy reacts to the coronavirus pandemic, Cerulli expects mutual fund allocations globally to become more conservative through the first half of the next decade. Global investors will look to re-allocate and assets pulled from equity funds are likely to flow not to bond products, but to money markets. With central banks around the world committing to keeping interest rates low for the foreseeable future, investors may not feel that the yields on bond funds are compelling enough to move them away from the safety and stability of money market vehicles.

The U.S. Federal Reserve has reduced short-term rates to nearly zero in a bid to spur the economy and the European Central Bank was at 0.00% and the Bank of Japan at -0.10% in July 2020. Bond yields are set to remain low for the rest of 2020—and likely into 2021.

Though global markets have stabilized somewhat after substantial losses during March and early April this year, fund managers worldwide stand to lose a significant market performance tailwind in 2020. Losing the aid of market appreciation will be a substantial challenge for managers already facing numerous hurdles, including fee compression, the rise of passives, and an increasing view of asset management as a commodity.

Cerulli expects manager consolidation, which largely paused in the first half of 2020 due to the coronavirus pandemic, to return in 2021 as markets stabilize. Underperforming managers present a ripe target for acquisition by multinational investment giants.

Around the world, investments into private markets slowed in the first half of 2020, with only US$433.7 billion of capital raised. The lockdown measures implemented in many countries to curb the spread of COVID-19 have affected business operations, due diligence, and investment decision-making processes for both managers and investors. Despite the headwinds, however, Cerulli expects investors to continue the process of diversifying into alternatives in search of better long-term returns.

In the institutional space, COVID-19’s effects on investors will be negative in the short term. Its impact will include insurers’ profit margins narrowing due to payouts on policies and pension sponsors reducing contributions where possible to keep their businesses going. However, institutional investors are starting to return to planned projects, boosted by the quick recovery in the financial markets.

“Overall, the volatility in the global financial markets caused by COVID-19 is likely to persist for the rest of 2020,” adds Schnurrenberger. “It is still unclear what the full impact of the coronavirus pandemic on the asset management industry will be, but it will inevitably dominate managers’ thinking and activity in the coming months and years. Nevertheless, those managers that respond effectively to their clients’ needs in these unprecedented times will find a growing opportunity set.”

© 2020 RIJ Publishing LLC.

‘A Payroll Tax Holiday Will Put the U.S. Back to Work’

Posted on August 6, 2020 by -

The U.S. response to the coronavirus pandemic and resulting economic collapse has been impressive in scale and speed, dwarfing the reaction to the 2008 global financial crisis. Provisions in the CARES Act and other measures were designed largely on the assumption that the economic shock would be sharp but short-lived. Policy support was intended to be a temporary bridge lasting a few months as things returned to normal.

With lay-offs mounting and many small businesses on the brink of failure, more fiscal assistance is necessary. A new stimulus round presents an opportunity to rethink employment incentives and get as many people back to work as possible. As the economy reopens, businesses should see demand rise, increasing the need to bring back workers. We need policies to encourage workers to rejoin the labor force, while assisting those who are working and experiencing reduced wages, hours or both.

A voluntary payroll tax holiday could play a pivotal role in boosting disposable income and incentives to work. Although Congressional Republicans are resisting this idea, that is a mistake. If structured correctly, it would also make Social Security more sustainable. The payroll tax withholding rate, currently 6.2% for the employee component, could be cut to zero for the first two years, delivering a much-needed income boost for workers who opt in. The rate could gradually rise after that, returning to 6.2% for the seventh year.

This would increase disposable income for existing workers, which would spur consumption and ignite a virtuous cycle that would encourage even more hiring. Under such a program, an average worker aged 40 earning an average wage ($53,756 in 2019) would receive $15,767 in increased disposable income over the next six years.

As a supply-side incentive to increase hiring, the employer could receive the same kind of tax holiday. Under the CARES Act, employers are allowed to defer 2020 payroll taxes. Outright elimination would deliver an even bigger economic boost. By driving down the after-tax cost of labor, businesses would receive an immediate incentive to hire and retain workers.

The result would be more record-setting job gains and a relatively rapid reduction in unemployment. Employer payroll tax relief would also relieve pressure on small businesses and limit failures and bankruptcies that threaten the economy’s structural potential.

This temporary payroll tax holiday could be offset by raising the retirement age for those who choose to participate. For instance, the full retirement age, now 67, could be increased by six months each year until it reaches 78 or retirement, whichever comes first. According to the Social Security Administration, the net present value of the Social Security Trust Funds’ unfunded liabilities over the next 75 years is $16.8 trillion.

This reform could eliminate $14.1 trillion of that deficit over the next 60 years, assuming a weighted average take-up rate of 66% among current workers. Moreover, roughly 36 million new entrants to the workforce over the next 15 years would produce extra savings of $4 trillion.

For those seeking current income, a higher net paycheck now would be available in exchange for delaying retirement. This could be attractive for younger workers whose expected retirement date is decades away. Aiding those who are working puts more money in the pockets of consumers, in turn lifting aggregate demand. Since the payroll tax cut is progressive — the 6.2% tax is only charged on the first $137,700 in personal income — lower-income workers, precisely those who need the most assistance right now and are most likely to consume the increased income, will see the largest relative increases in take-home pay.

Unlike a mandatory reform, workers who opt for the payroll tax holiday would do so willingly in exchange for an extended retirement age. Those who wish to retain their current retirement benefits would continue in the existing program. This would give them greater freedom and flexibility to customize their retirement.

A payroll tax holiday is a useful incentive to stimulate employment while creating an opportunity for entitlement reform that will shore up Social Security for future generations. Clearly, this proposal must be just one component of a much larger fiscal package. Such measures should be complemented by continued advances in public health policy and support from monetary policy. We should grab this chance to design a program that returns the U.S. to work, while enhancing its financial stability and economic growth.

John B. Taylor, Stanford economics professor and Hoover Institution fellow, also contributed to this article.

 

Low rates are ‘key obstacle’ for U.S. life/annuity firms: AM Best

Posted on August 6, 2020 by -

An AM Best analysis of U.S. life/annuity companies’ investment strategies amid the past decade of low interest rates found that the number of companies considered non-interest-sensitive more than doubled those deemed interest-sensitive.

However, those companies exposed significantly to interest rates have managed an average 76% of the industry’s invested assets in the last 10 years, and have different investment risk tolerances and strategies to aid in backing a product profile that is linked more to interest rates.

The low interest rates continue to hamper the life/annuity (L/A) industry, and with the COVID-19 pandemic impact, the trend is likely to exacerbate. In a new Best’s Special Report, “Interest Rates: Different Impact Severity, Different Strategies,” AM Best notes that insurers have been strategically de-risking their product portfolios for some time to counter the impacts on spread compression and earnings volatility.

Strategies have included exiting, re-pricing or de-emphasizing certain business lines, particularly those that are interest-sensitive. According to the report, companies considered interest-sensitive were those with a liability and premium mix concentrated in individual and group annuities, deposit-type contracts and interest-sensitive life products, as defined by the NAIC for statutory statement reporting.

Interest-sensitive companies typically generate the bulk of the industry’s earnings. Based on 2019 capital and surplus levels, interest-sensitive companies have nearly four times the amount of capital on average—approximately $2.3 billion, compared with roughly $610 million for non-interest-sensitive companies.

Commercial mortgage loans remain a staple of life insurers’ investment holdings, growing more than 80% to $578.5 billion in 2019 from $317.1 billion in 2010. Interest-sensitive companies were responsible for the growth, as their average exposure rose to 8.2% in 2019 from a low of 5.8% in 2010, versus a slight decline in non-interest-sensitive companies, whose average exposure came to 4.2% of invested assets in 2019.

Pre-tax net operating gains have been relatively consistent for non-interest-sensitive companies. In contrast, interest-sensitive companies have reported much more fluctuation over the last 10 years, although earnings have been consistently positive. Interest-sensitive companies also earn higher yields on average than non-interest-sensitive companies.

The low interest rates will remain a key obstacle as L/A insurers continue to invest new money, as well as the proceeds from higher-yielding maturing assets, into new assets at lower rates. The COVID-19-fueled economic slowdown has amplified the likelihood of dampened earnings in 2020 for spread and fee-driven businesses.

AM Best believes there is the potential for further swings in the equity markets, and will be looking closely at companies’ asset-liability management programs as closely matched assets and liabilities can immunize against interest-rate sensitivities.

© 2020 RIJ Publishing LLC.

Virus and low-rates cut deep into Q2 annuity sales: LIMRA SRI

Posted on July 30, 2020 by -

Total U.S. annuity sales fell to $48.8 billion in the second quarter of 2020, down 24% from the second quarter of 2019, according to preliminary results from the Secure Retirement Institute (SRI) U.S. Individual Annuity Sales Survey.

“The second quarter annuity sales decline is a direct result of the global pandemic and its economic fallout,” said Todd Giesing, senior annuity research director, SRI, in a release this week.

“In addition to the record-low interest rates and continued market volatility, social distancing has significantly disrupted business operations for companies and advisors over the past three months,” he added.

“While most annuity products saw double-digit sales declines, products that offer investment protection, like fixed-rate deferred and registered index-linked annuities, were able to maintain and even grow business in the second quarter.”

After four consecutive quarters of growth, total variable annuity (VA) sales dropped 20% in the second quarter to $20.5 billion. VA sales were $46.5 billion in the first half of 2020, down 4% from the first half of 2019. This was the lowest quarterly level of variable annuity sales since 1996.

While overall VA sales declined, registered index-linked annuity (RILA) sales (also known as structured variable annuities) continued to grow. RILA sales were almost $4.5 billion in the second quarter, 8% higher than in second quarter 2019. RILA have now seen quarter-over-quarter growth for 22 consecutive quarters. Year-to-date, RILA sales were $9.4 billion, up 22% from the first half of 2019.

“As we saw over the last few quarters, the low interest rates have hampered fixed indexed annuity (FIA) rates. As a result, we believe advisors are gravitating to RILAs, which offer downside protection with greater upside potential,” Giesing said.

The growth in RILA sales has come at the expense of FIA sales. In the second quarter, FIA sales fell 41% to $11.9 billion. This is the lowest quarterly total for FIAs since first quarter 2015. Year-to-date, FIA sales totaled $28.1 billion, falling 26% compared with prior year.

Total fixed annuity sales were $28.3 billion in the second quarter, a 26% decline from second quarter 2019. In the first half of 2020, fixed annuity sales dropped 24% to $58.1 billion.

Fixed-rate deferred annuity sales jumped 33% from the prior quarter to $13.0 billion. Year-to-date, fixed-rate deferred annuity sales totaled $22.8 billion, which is 19% lower than prior year results.

“Low interest rates dampened fixed-rate deferred annuity sales in the first quarter. But, as we saw during the Great Recession, sles of these products soared in the second quarter as consumers looked to protect their investment from market volatility and losses,” Giesing said.

Income annuity sales suffered as a result of historically low interest rates. Single premium immediate annuities (SPIAs) were $1.5 billion in the second quarter, down 44% from the second quarter of 2019. This is the lowest quarterly level of SPIA sales in 13 years. Year-to-date, SPIA sales were $3.4 billion, down 38% compared with sales results from the first six months of 2019.

Deferred income annuity sales (DIA) were cut in half to $370 million in the second quarter. Year-to-date, DIA sales were $840 million, sinking 38% from prior year results. “We believe investors will hold off purchasing income annuity products, hoping interest rates rebound over the next 6–12 months,” Giesing said.

Preliminary second quarter 2020 annuities industry estimates are based on monthly reporting, representing 81% of the total market. A summary of the results can be found in LIMRA’s Fact Tank.

The top 20 rankings of total, variable and fixed annuity writers for the first half of 2020 will be available in August, following the last of the earnings calls for the participating carriers.

© 2020 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on July 30, 2020 by -

Net worth of $655k = Happiness, Schwab survey suggests

More than half (57%) of Americans say that they or a close family member have been financially impacted by COVID-19, according to Charles Schwab’s 2020 Modern Wealth Survey. But the survey also revealed positive changes in Americans’ financial behaviors.

According to the survey:

  • 36% of Americans say they are more likely to have savings to cover emergency expenses
  • 40% say they are more likely to be saving more today than before the pandemic outbreak in the U.S.
  • 24% say they are now more likely to have a financial plan; around 30% still express some apprehension about investing
  • Roughly 20% say they are more likely to invest in the stock market (19%) or start investing (22%) during this time

Americans report that their overall happiness depends much more on the quality of their personal relationships than on the amount of money they have. Still, only one quarter feel highly confident about reaching their financial goals—down from one-third when surveyed in January 2020.

Schwab’s 2020 Modern Wealth Survey is comprised of data gathered from 1,000 respondents in January 2020 before the widespread COVID-19 outbreak in the U.S., and again in June 2020.

When asked in June “what it takes to be financially comfortable now,” Americans, on average, named a net worth of $655,000. say it takes much less than it did in January. That was down nearly 30% from the January 2020 survey, when their comfort level stood at an average of $934,000.

The bar for the level of assets that Americans think it takes to be considered wealthy has been lowered as well. Today they feel that an average of $2.0 million in net worth equates to wealth, down 23% from an average of $2.6 million in January.

In the midst of the COVID-19 pandemic, 30% of survey respondents say they or a family member have experienced a salary-cut or reduced work hours, and 25% say either they or a family member have been furloughed or laid off. Millennials are the most affected of all generations, with 41% stating that they or a family member have experienced one of these issues.

Regarding financial stress (on a scale of 0 to 100), the survey showed that Americans are almost 15% more financially stressed today than they were at the end of 2019. Americans also expect their financial stress levels to stay somewhat elevated even after the pandemic passes.

In both the January and in June surveys, Millennials were the most financially stressed generation and Baby Boomers were the least financially stressed.

Logica Research conducted both waves of the Schwab survey, in which 1,000 Americans aged 21 to 75 were polled. Quotas were set to make each wave of the survey demographically representative.  The margin of error for the total survey sample is three percentage points.

Athene to hold earnings call August 5

Athene Holding Ltd., the $142 billion owner of life insurers and a Bermuda-based reinsurer, will release financial results for the second quarter 2020 on Wednesday, August 5, 2020, before the opening of trading on the New York Stock Exchange.

The news release, financial supplement, and earnings presentation will be available on the ir.athene.com website. Management will host a conference call to review Athene’s financial results on the same day at 10:00 a.m. ET.

Conference Call Details

Live conference call: Toll-free at (866) 901-0811 (domestic) or (346) 354-0810 (international). Conference call replay available through August 19, 2020 at (800) 585-8367 (domestic) or (404) 537-3406 (international)

Conference ID number: 4259196

Live and archived webcast available at ir.athene.com

Athene, through its subsidiaries, issues, reinsures and acquires retirement savings products designed for the increasing number of individuals and institutions seeking to fund retirement needs. The products offered by Athene include:

  • Retail fixed, fixed indexed, and index-linked annuity products
  • Reinsurance arrangements with third-party annuity providers
  • Institutional products, such as funding agreements and the assumption of pension risk transfer obligations

Athene had total assets of $142.2 billion as of March 31, 2020. Its principal subsidiaries include Athene Annuity & Life Assurance Company, a Delaware-domiciled insurance company, Athene Annuity and Life Company, an Iowa-domiciled insurance company, Athene Annuity & Life Assurance Company of New York, a New York-domiciled insurance company and Athene Life Re Ltd., a Bermuda-domiciled reinsurer.

RIAs can now access Pacific Life fee-only annuities on the Orion platform

Pacific Life’s commission-free variable annuity and fixed indexed annuity are now integrated with the Orion Advisor Solutions platform and available for purchase by registered investment advisors for their clients, the insurer announced this week.

Orion is a “tech-enabled fiduciary process” or platform that enables “financial advisors to prospect, plan, and invest” within a single platform, according to a release.

The Orion integration will allow financial advisers to monitor and bill on their clients’ tax-advantaged retirement-income solutions. RIAs can manage a client’s portfolio of both taxable and tax-advantaged assets within a single workstation. This feature allows advisers to combine investments and insurance products more easily.

To support its outreach to RIAs, Pacific Life has added a dedicated RIA channel team, and “continues to add new custodians and insurance licensing companies to make it as simple as possible for financial advisors to include critical guaranteed income in their clients’ portfolios.”

Fed to maintain target fed funds rate of zero to 0.25%

The Federal Reserve issued the following statement this week:

The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.

The coronavirus outbreak is causing tremendous human and economic hardship across the United States and around the world. Following sharp declines, economic activity and employment have picked up somewhat in recent months but remain well below their levels at the beginning of the year.

Weaker demand and significantly lower oil prices are holding down consumer price inflation. Overall financial conditions have improved in recent months, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.

The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.

In light of these developments, the Committee decided to maintain the target range for the federal funds rate at 0 to 1/4 percent. The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.

The Committee will continue to monitor the implications of incoming information for the economic outlook, including information related to public health, as well as global developments and muted inflation pressures, and will use its tools and act as appropriate to support the economy.

In determining the timing and size of future adjustments to the stance of monetary policy, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective.

This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

To support the flow of credit to households and businesses, over coming months the Federal Reserve will increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace to sustain smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions.

In addition, the Open Market Desk will continue to offer large-scale overnight and term repurchase agreement operations. The Committee will closely monitor developments and is prepared to adjust its plans as appropriate.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Loretta J. Mester; and Randal K. Quarles.

SEC charges VALIC financial advisers

The Securities and Exchange Commission has charged Houston-based VALIC Financial Advisors Inc. (VFA) in a pair of actions for failing to disclose practices that generated millions of dollars in fees and other financial benefits for VFA. Teachers and other investors were affected, the SEC said.

In the first action, the SEC found that VFA failed to disclose that its parent company paid a for-profit entity owned by Florida K-12 teachers’ unions to promote VFA and its parent company services to teachers.

In the second action, the SEC found that VFA failed to disclose conflicts of interest regarding its receipt of millions of dollars of financial benefits that directly resulted from advisory client mutual fund investments that were generally more expensive for clients than other mutual fund investment options available to clients.

“VFA agreed to pay approximately $40 million to settle the charges in these two actions.  In the first action, VFA agreed to cap advisory fees for all Florida K-12 teachers who currently participate (and, in some cases, those who prospectively participate) in its advisory product in Florida’s 403(b) and 457(b) retirement programs.  This will result in significant savings for thousands of teachers,” an SEC release said.

© 2020 RIJ Publishing LLC. All rights reserved.

Is a P.E.P. Rally About to Start?

Posted on July 30, 2020 by -

Willis Towers Watson and Aon, two publicly-traded, global, diversified human resource and financial consulting firms are looking to create large defined contribution retirement plans—”Pooled Employer Plans,” or PEPs—and invite dozens or hundreds of smaller companies to join.

That was my takeaway from reading their comments in response to the Department of Labor’s (DOL) Request for Information about potential conflicts of interest as financial services companies take advantage of the 2019 SECURE Act to initiate retirement plans, serve as the plan fiduciary, and also sell their own products to the participants.

“Willis Towers Watson is considering establishing a PEP [Pooled Employer Plan] and becoming a PPP [Pooled Plan Provider],” the firm said in its letter to the DOL. Aon’s letter said, “The Aon PEP is designed to be a bundled solution for participating employers, utilizing the expertise of both affiliated and non-affiliated service providers of Aon.”

The era when small business owners often relied on their own personal (but not necessarily pension-savvy) financial advisers to help them start tiny, over-priced, labor-intensive 401(k) plans for themselves and a handful of employees—or go without a plan at all—may be ending on January 1, 2021. That’s when PEPs can go live.

It’s possible that the history of retirement savings in the U.S. is about to turn a corner. The current moment reminds me of the early 1980s, when deregulation began to transform the banking and health insurance businesses.

Or PEPs could turn out to be a small phenomenon, already enabled under current law. In his comment letter, attorney Robert Toth said that the new PEPs, though now formally permitting unrelated employers to join single plans, won’t in practice add much to the status quo, beyond offering those employers consolidated annual reporting. In PEPs each employer will remain a co-sponsor of the plan, rather than ceding sponsorship to the PPP.

“What could have happened in SECURE, but did not, was to turn 401(k)s into a pure commodity, with employers not having much of any responsibility other than adopting it,” Toth said in an email to RIJ. “AON, for example, is not sponsoring the plan. They are merely a sort of ‘super’ service provider of the type we are already using.”

Instead, the PEP rules specifically kept the traditional obligations of the employer/sponsor; they are treated as if they were sponsoring their own plan, with all the obligations.

It’s confusing, and it’s not at all clear where all this will lead.

Many of the other 30 letters to the DOL—all from law firms, trade associations, or specific companies, plus AARP—attested that financial services companies, or different arms of the same company, should be able to provide oversight to the plan while marketing their products to plan participants.

Some firms said the DOL needs to issue new and specific exemptions from certain existing conflict-of-interest prohibitions before they can legally offer 401(k) plans. Empower Retirement’s letter said, perhaps signaling its interest in marketing group annuities to participants in its own PEP:

“We do not believe there is an existing prohibited transaction exemption that would allow a PPP or an open MEP sponsor, acting with investment manager under ERISA Section 3(38), to retain compensation associated with general account group annuity contracts. Therefore, we recommend the DOL engage with the industry in discussions about a workable prohibited transaction exemption to allow insurance company commercial entities operating as PEP or open MEP sponsors to offer proprietary general account products.”

Empower expressed a definite concern that the DOL rules currently don’t make it clear that existing full-service plan providers like itself can offer retirement plans, be its own primary watchdog, largely determine its own compensation, and offer proprietary products, without committing a conflict-of-interest violation under current law.

Transamerica, which has a history of serving as the recordkeeper for Multiple Employer Plans (a predecessor of PEPs), also submitted a letter. It asked the DOL to ensure that a trustee of a PEP could transfer the chore of collecting participant contributions to a PEP 401(k) account to a recordkeeper like Transamerica. Evidently, Transamerica wants to make sure that it has a seat at the table in PEPs.

I was scouring the letters for references to annuities. A letter from attorney Steve Saxon of the Groom Law Group sought to clarify the rules around the setting of direct or indirect compensation—revenue sharing, for instance—for fixed annuity providers that may or may not be affiliated with the PEP recordkeeper. He seemed to tie fixed annuities with target date funds; adding an annuity to a target date fund is one way that a lifetime income feature could be added to a 401(k) plan.

My sense is that the Trump DOL leans toward deregulating the retirement industry. In effect, that’s what the SECURE Act seems to have done by letting a wide variety of companies start offering retirement plans and, to an unprecedented degree, letting them police their own conduct to an unprecedented agree. (As noted above, Bob Toth doesn’t agree with my dramatization of the situation.)

This contrasts sharply with the Obama DOL’s fiduciary rule, which would have extended the umbrella of consumer protections that govern tax-deferred employer-sponsored retirement plans to include tax-deferred brokerage IRAs. The current Labor Secretary, Eugene Scalia, was part of the legal team that led the successful fight to void the Obama DOL’s “fiduciary rule.”

I have been wary of the SECURE Act because its public policy goal was never transparently stated. Bipartisan sponsors of the bill said it would help small companies “band together” to bargain for better, less expensive retirement plan services.

That’s not quite how the bill was ever meant to foster new economies of scale, in my understanding. Rather, it appears to encourage the creation of industry-led retirement plans, run by a wide variety of companies, that will serve dozens or hundreds of small companies and their employees. I’ve been told that the two descriptions amount to the same thing, but I disagree.

© 2020 RIJ Publishing LLC. All rights reserved.

Fed Frets Over Fiscal Cliff

Posted on July 30, 2020 by -

The Federal Reserve reiterated its intention to “act as appropriate to support the economy” at the conclusion of this week’s policy meeting while worrying that resurgence of the virus threatens to derail the recovery.

Federal Reserve Chair Jerome Powell emphasized the importance of fiscal policy in supporting the recovery, a not-thinly veiled hint that Congress (or, more specifically, Senate Republicans) need to get their act together.

No new policy measures were announced although Powell did hint that the policy review would be complete by September. Overall, a dovish message. The Fed intends to maintain accommodative financial conditions for years.

The FOMC statement was little changed from June, with the most notable addition being:

“The path of the economy will depend significantly on the course of the virus.”

This is not exactly news for most of us, but the Fed felt it important to emphasize that there is no tradeoff between the economy and public health. Until the virus comes under control, the economy can’t full recovery. The Fed is especially concerned that a resurgent virus already worsens the outlook. From Powell’s opening statement:

“Indeed, we have seen some signs in recent weeks that the increase in virus cases and the renewed measures to control it are starting to weigh on economic activity.”

Powell reviewed the Fed’s actions to support the economy and highlighted the importance of fiscal policy in minimizing the extent to the recession:

“Elected officials have the power to tax and spend and to make decisions about where we, as a society, should direct our collective resources. The fiscal policy actions that have been taken thus far have made a critical difference to families, businesses, and communities across the country. Even so, the current economic downturn is the most severe in our lifetimes. It will take a while to get back to the levels of economic activity and employment that prevailed at the beginning of this year, and it will take continued support from both monetary and fiscal policy to achieve that.”

Powell commented heavily on fiscal policy, including praising the steps taken to date while making clear that the job is not done. It is hard to interpret Powell’s position as anything less than a rebuke to Senate Republicans who have positioned the U.S. economy to fall over a fiscal cliff despite months of warning.

Powell could not be happy that he has to be the adult in the room; the Fed would prefer to stay out of fiscal policy. My suspicion is that he doesn’t think staying quiet is an option. Why? Because buried under Powell’s plead for more fiscal support was the implication that the Fed would be unable to compensate for a fiscal retreat.

To be sure, in response to a reporter’s question Powell said the Fed has more tools available. Those tools, however, would not be sufficient to compensate for the fiscal cliff that lies ahead.

Powell said that meeting participants discussed the policy and strategy review and that they will “wrap up our deliberations in the near future.” That to me sounds like September. He did not give any hints as to the outcome of that process. He played his cards a little closer to his vest than I anticipated. We will need to wait until the Fed releases the meeting minutes to learn more about the discussion.

The overall message was dovish: Powell indicated that disinflationary pressures were likely to dominate for the foreseeable future, that the recovery would not happen quickly and hence unemployment would remain persistently high, and that people really need to stop asking him when they will consider raising rates. That question is so far from his mind that he can’t even begin to answer it.

Bottom Line: The Fed remains committed to accommodative policy. I expect that the Fed will conclude its policy review by September and then they will be free to take additional action. The three most obvious future actions are enhanced forward guidance, shifting asset purchases to the long-end of the yield curve, and yield curve control at the short end. Those would most likely occur prior to an expansion in the pace of asset purchases.

© 2020 Tim Duy’s Fed Watch. The original blogpost was published here.

The Key to Turning On 401(k) Annuities

Posted on July 29, 2020 by -

Before income-generating annuities can become a common feature in 401(k) plans—as they are in TIAA’s 403(b) plans—plan recordkeepers will need an easier way to swap data with the life insurers who badly want to market annuities through those plans.

The SECURE Act of 2019 partly relieved plan sponsors of legal anxiety about offering annuities. But it didn’t solve the need for headache-free administration of annuities, which, like molting insects, are born in plans and take flight after participants retire.

“With the passage of the SECURE Act, the fiduciary concern is no longer the primary concern,” said Mike Westhoven, who has worked for years on this issue. “So the top concern now is about administration. All parties know they can’t have messy one-off connections. They want one place to access data on a variety of products.”

Westhoven now works for Micruity, a tech startup with a blueprint for the much-needed data hub. He and Micruity CEO Trevor Gary have been running demos of their “middleware” solution for asset managers and life insurers, who could include it in their proposals to plan sponsors.

Trevor Gary

Micruity’s solution can accommodate the inclusion of any type of annuity in a 401(k) plan. That flexibility is essential, because 401(k) annuity can take many shapes. The annuity can be purchased in or outside the plan, and with multiple premiums or a lump sum. It can require an “opt-in” by the participant or use a default.

As for the contract itself, it might be a permanently liquid deferred variable annuity, or an irrevocable life annuity, or a tax-deferred QLAC (qualified longevity annuity contract). The participant might switch on the guaranteed income stream at retirement, or after 10 to 20 years, or never. The plan sponsor might offer annuities from one insurer or from two or three. Given the evolving state of this industry, all options are on the table.

The ‘admin’ problem

Selling one annuity to a retail client can be complicated; scaling the sale of dozens or hundreds annuities to waves of retiring plan participants every year is much more so. The plan’s existing stakeholders—the recordkeeper, asset managers and participants—need to accommodate the data needs of one or more annuity providers.

“You need a system to keep the books and records straight,” said Mark Fortier, who in 2012 helped add income riders from three life insurers to an AllianceBernstein TDF in United Technology Corp.’s 401(k) plan. “Someone needs to connect the recordkeeper data with the insurer data, the way it’s currently done on the investment side. You need an entity in the middle.”

Ideally, there should be a single point of contact where every entity can access all the data that’s required to fund participants’ annuities, close the sale of the annuity at retirement, and make sure participants receive checks at the correct addresses throughout retirement.

Enter Micruity

Less than three years ago, Toronto native Trevor Gary was on the pension actuarial team at Deloitte Canada working on longevity risk swaps. Recognizing the need for personal pensions in the U.S., he decided to build a retail app with which individuals could calculate the gap between their expected retirement expenses and their expected Social Security benefits.

“Then on the back end of the app, our system would enable people to pay as little as $100 would be the Micruity system, where people could contribute $100 every payday to an annuity,” Gary, who is 30, told RIJ recently. “We would have annuities from eight different providers. I wanted to build it on the blockchain. Everybody took a meeting with me but they all said, ‘You’re nuts.’”

Instead, Micruity spent four months in a tech incubator program in Des Moines, the Global Insurance Accelerator, getting mentored by life insurance executives. There Gary learned about the opportunity in the 401(k) annuity space for a service that could track participant data to and through retirement. after they’d bought annuities and retired.

“The [life insurers] said, ‘When people leave the plan, we need to be able to track them.’ That was the Eureka moment for me,” Gary said. “From there, we built our current system from scratch.”

Last April, Micruity made presentations of his system to an audience at SPARK, the association of recordkeepers. This spring, Gary and Westhoven produced a webinar on the Micruity system called, “Making Lifetime Income Real.” As they explain in the webinar, Micruity’s product has three components:

  • ‘Accumulation’ product. The most common in-plan annuity design is a deferred variable annuity with a guaranteed lifetime withdrawal benefit (i.e., a target date fund with a GLWB). When a participant in such a fund reaches age 50 or 55, Micruity would start collecting data from the plan recordkeeper and sharing it with a life insurer, which would begin assessing an annual fee in return for putting a floor under the participant’s “benefit base”—the basis for calculating the participant’s minimum annual income in retirement.
  • ‘Income Election’ product. As groups of participants reach retirement age, Micruity would facilitate an “Income Election Decision Experience.” “We’re the data conduit sitting in the middle,” Gary told RIJ. “We can move that data in a frictionless, secure way. In a single sitting, we validate the participants’ identification and banking information. We enable them to e-sign a contract or certificate and provide a digital notary. We digitize the whole process.”
  • ‘Payment Aggregation’ product. Depending on the kind of annuity purchased, the retiree might receive regular income from multiple insurers. Income might begin immediately after retiring, at a specific age, or whenever the retiree wishes. With GLWB products, the asset manager handles the payments. For non-GLWB products, Micruity would keep track of address changes, aggregate payouts from the several life insurers and issue checks. It also provides an online service center and call center support. Micruity’s fees for the TDF provider and life insurer could be AUM-based or transaction-based, and “could range from five to fifteen basis points depending on the product design and Micruity services,” Gary said.

“The sponsor is thinking, ‘This is a new product, so how do we make the process as frictionless as possible?’ Westhoven said. “They don’t want to add a speed bump that makes it difficult to use. With participants, there’s no such thing as a speed bump; every obstacle to usage is more like a brick wall.”

Mike Westhoven

Outside observers are encouraged by Micruity’s efforts so far. “The data hub and administration is the foundation, but Micruity could probably help on the participant experience and education, if stakeholders desire,” said Fortier. “Data-privacy, administration, and the regulatory aspects of education between recordkeepers and insurers have risks that have challenged the unbundled approach in the past.”

Robert Melia, the executive director of the Institutional Retirement Income Council (IRIC), a coalition of plan providers started by Prudential when it launched its IncomeFlex TDF/GLWB, told RIJ that Micruity could bring standardization to what is still a disjointed business.

“Micruity could say, ‘Let us provide these services, and we’ll establish the standardization that’s needed to drive annuities in DC plans,’” Melia said. “They have the credibility, the reputation and the knowledge to put it all together. Standardization, more than anything else, might propel the income part of the DC industry into the future.”

Not much demand yet

Legal liabilities and data gaps are not the only things stopping plan sponsors from adopting annuities. Participants aren’t demanding annuities, or pressuring employers to offer them—though that’s not necessarily a deterrent for Micruity and its clients. (“The plan sponsors say that participants aren’t asking for annuities. But participants didn’t beg for TDFs either,” Westhoven told RIJ.)

Micruity’s End-to-End Service

Lack of active demand for annuities could be a problem, however. The target market for annuities includes participants who’ve been defaulted into TDFs. Their very passivity makes them attractive to annuity vendors, since they can be defaulted into a GLWB rider as they near retirement. But will plan sponsors acquiesce to such an arrangement, especially if the rider costs as much as 100 basis points per year?

Efforts by full-service plan providers like Prudential and Empower to market TDF/GLWB products to their institutional clients have yielded lackluster results. Westhoven’s former employer, DST Systems (since acquired by SS&C Technologies), created middleware called RICC (for “Retirement Income Clearinghouse Calculator”), but it has remained largely on the shelf.

Historically, annuities have shown the most promise in two distinct types of plans. They appear to work well in 403(b) plans, where millions of people have access to TIAA annuities. They also seem to be a good fit at large companies that recently closed defined benefit pensions and where a critical mass of employees misses an income option. United Technologies is the singular example of such a company.

Micruity will be aiming its future marketing efforts at just such large firms. “We’re looking at the top 1,600 plans, with a combined 20 million or more participants, Gary told RIJ. “These plans have strong human resource teams, and often have a unionized or union-like environment. They employ a lot of mid-market Americans, and their turnover rate is low as they get closer to retirement. These are the plans where it will start. And once momentum catches on, changes will trickle down to smaller plans.”

© 2020 RIJ Publishing LLC. All rights reserved.

Retirement Income Budgets: An Actuarial Approach

Posted on July 24, 2020 by -

A retirement income budget can be defined as the amount of money that one can generate on a gross (pre-tax) basis from all potential sources. A spending budget in retirement in important, but an income budget should come first. It sets the limits of the spending budget.

Retirees can generate income, for instance, from Social Security, a company pension, an insured annuity, investments (including earnings and principal), home equity, as well as other sources. Individual sources of income could be constant, increasing, or decreasing. The combined income should ideally be designed to last for the lifetime needs and to meet the goals of the individual or couple.

The challenge stems from the complexity of addressing individual uncertainties regarding life expectancy, financial markets, and events that may require an unknown financial expenditure such as home repair, a real estate assessment, or long-term care. (To help predict life expectancies, the American Academy of Actuaries offers an Actuaries Longevity Illustrator.)

Among the actuarial principles that apply to retirement income budgeting are periodic reevaluation and risk pooling (specifically longevity pooling). Without longevity pooling, an individual might need to plan to spend a fixed amount of assets over the longest plausible lifetime, resulting in less income each year.

Longevity pooling can provide more each year by allowing the individual to plan around the average longevity of many similarly aged retirees. It shares a pool of assets that provides lifetime income to all participants regardless of how long they live. Social Security, defined benefit pension plans, and lifetime annuities sold by insurance companies are examples of this practice.

Overview

This report describes three general approaches for drawing down personal savings and assets that are not part of a longevity risk pool. All three approaches could include either or both tax-qualified and non-tax-qualified funds, thereby adding tax consequences as a consideration.

Required Minimum Distribution Approach

The required minimum distribution (RMD) approach entails an annual redetermination of the amount to withdraw, based on an approximation of life expectancy and the account balances at the end of the prior year.

The approach is simply to draw down assets (from qualified and non-qualified sources) at the rate specified for RMD, either starting at age 72 or before. (That is, the RMD approach works even if the individual has not reached the IRS’ “required beginning date.”)

This approach improves on other simple approaches such as the “X% Rule” (e.g., 4% rule), which do not adjust for remaining life expectancy. With other simple approaches, a market decline could mean that the income doesn’t last for the individual’s entire lifetime, doesn’t generate enough income to maintain the retiree’s standard of living, or results in an larger-than-desired bequest.

Pros. The calculation is relatively simple and can be done by the retiree with the published values in the IRS tables. The annual drawdowns are based on the life expectancy tables, so the income will continue throughout a lifetime while automatically adjusting for a reducing life expectancy. This method doesn’t require investment return assumptions because actual returns are reflected in the assets supporting the next year’s spending level.

Cons. The life expectancy used is “one size fits all.” It is not tailored to an individual’s situation. It is based on the lives of the retiree and a beneficiary (with a 10-year-younger age for the beneficiary), and thus will understate the amount of income that can be withdrawn for only a single life expectancy.

It neglects to recognize health status, so a person in poor health might want to withdraw funds more rapidly. Income will vary from year to year. The greater the investment allocation to equities, the larger the annual swings in income could be. There is no formal inflation adjustment, although, absent investment volatility, income often will rise in earlier years and fall much later in retirement. In addition, this approach does not coordinate income from other sources with the income generated by the investments.

Deterministic Scenario Approach

The deterministic scenario approach requires assumptions such as life expectancy, the overall investment return, and possibly inflation. The life expectancy is calculated from a mortality table and is based on current age and gender. This is then often adjusted to reflect health status, conservatism (addition of several years to life expectancy),
and the availability of other reliable sources of income.

The investment-return assumption can range from a conservative rate to an actual expected return based on the portfolio’s asset allocation and capital market expectations. The calculations can be done with either set of investment return assumptions to provide a range of outcomes.

Then, based on the assumed life expectancy, expected investment return, and the amount of retirement savings, an expected income level is determined. The model can also be adjusted for annual increases in income, modifications to desired income at later stages of retirement, and market volatility. It can also encompass other sources of income.

There is the option to consider the impact of longevity pooling by measuring the results of alternative approaches that take into account the purchase of fixed income immediate annuities or delayed Social Security.

This approach should be revisited annually to adjust for past investment income experience, actual expenditures, changes in the planned income pattern, or modified mortality, investment, and inflation assumptions.

Pros. Calculators for this approach can be found on the Internet, provided by investment managers, brokers, and financial bloggers. Performing calculations with several sets of assumptions, particularly those relating to investment income, life expectancy, and inflation, can reveal the range of affordable lifetime income possibilities.

The method provides a specific amount that can be available for spending, which makes it easy to put into action; however, the calculations must be periodically updated to reflect actual investment returns.

Cons. Care must be taken in the choice of assumptions. Use of unrealistic assumptions can lead to either overstating or understating an affordable lifetime income level. Modeling can be more complex when considering non-investment-portfolio sources of income.

Probabilistic Scenario Approach

Like the deterministic scenario approach, the probabilistic scenario approach is based on a model with certain assumptions. Instead of relying on a single life expectancy or investment return assumptions, it uses stochastic modeling to generate thousands of simulations based on a range of possible experience.

A planning strategy generally comprises an annual income goal, which can be flat or varying, and includes all sources of income Within the simulations, rates of return are generated for each year based on Monte Carlo techniques. Rates of return generated are based upon both an expected return and volatility. Simulations recognize age-based mortality rates, or incorporate a randomly generated age at death that is based on mortality tables that reflect sex, health, and possibly other factors.

The thousands of results from the simulations can then be categorized in various ways to determine the probability of certain outcomes, such as the expected range of the level of income or the range of bequests. Alternative planning strategies can be considered. This approach should be revisited periodically. Longevity pooling is considered if annuities or the timing of Social Security are taken into account.

Pros. This method produces thousands of potential outcomes for each planning strategy that’s analyzed. Those outcomes can be categorized to assign probability of occurrence. For example, a given strategy might show that it would satisfy the retiree’s lifetime income goal 95% of the time. Competing strategies can be analyzed to determine their relative attractiveness. The model must be kept up to date with periodic updates.

Cons. The results require the ability to interpret a percentile range or a chance of failure. The results are only as good as the assumptions. Selection of assumptions regarding expected returns, expected variances in those returns, and covariances in returns among asset classes can be complex. The required effort may discourage periodic reevaluation and readjustment.

© 2020 American Academy of Actuaries. A longer version of this white paper can be found here.

Honorable Mention

Posted on July 24, 2020 by -

UBS to pay $10 million to settle “flipping” charges: SEC

UBS Financial Services Inc., one of four “wirehouses” or full-service brokerages in the U.S., will pay more than $10 million to resolve federal charges that for four years it “improperly allocated bonds intended for retail customers to parties known in the industry as “flippers,” the Securities and Exchange Commission announced this week.

These individuals purchase new issue municipal bonds, often by posing as retail investors to gain priority in bond allocations. The defendants then “flip” the bonds to broker-dealers for a fee.

The order imposes a $1.75 million penalty, $6.74 million in disgorgement of ill-gotten gains plus over $1.5 million in prejudgment interest, and a censure. Two UBS registered representatives, William S. Costas and John J. Marvin, were fined and will incur a 12-month “limitation” from trading in negotiated new municipal securities.

The SEC previously settled charges against Jerry E. Orellana, a former UBS Executive Director, for submitting retail orders to the underwriting syndicate from certain UBS customers who were flippers.

Without admitting or denying the findings, UBS consented to a cease-and-desist order that finds it violated the disclosure, fair dealing, and supervisory provisions of Municipal Securities Rulemaking Board Rules and the Securities Exchange Act of 1934.

“UBS registered representatives knew or should have known that flippers were not eligible for retail priority,” the SEC order said, adding that “UBS registered representatives facilitated over 2,000 trades with flippers, which allowed UBS to obtain bonds for its own inventory, thereby circumventing the priority of orders set by the issuers and improperly obtaining a higher priority in the bond allocation process.”

The SEC also charged UBS registered representatives William S. Costas and John J. Marvin with negligently submitting retail orders for municipal bonds on behalf of their flipper customers. Costas was charged with helping UBS bond traders improperly obtain bonds for UBS’s own inventory through his flipper customer.

Costas and Marvin agreed to settle the charges without admitting or denying the SEC’s findings, and consented to orders finding they violated MSRB Rules G-11(k) and G-17.  Costas agreed to pay disgorgement and prejudgment interest totaling $16,585 and a civil penalty of $25,000, and Marvin agreed to pay disgorgement and prejudgment interest totaling $27,966 and a civil penalty of $25,000.

The SEC’s investigation was conducted by the Division of Enforcement’s Public Finance Abuse Unit, which is led by LeeAnn G. Gaunt. The investigators included Joseph Chimienti, Laura Cunningham, Warren Greth, Cori Shepherd, and Jonathan Wilcox, with assistance from Deputy Unit Chief Mark Zehner and Assistant Director Kevin Guerrero.  Ivonia K. Slade supervised the investigation.

Jackson National completes sale of equity stake to Athene

Jackson National Life Insurance Company today announced the completion of a $500 million equity investment from Athene Holding Ltd. in return for a 9.9% voting interest corresponding to an 11.1% economic interest in Jackson.

Jackson has $297.6 billion in total IFRS assets and $269.5 billion in IFRS policy liabilities set aside to pay primarily future policyowner benefits (as of December 31, 2019).

Jackson is an indirect subsidiary of Prudential plc, an Asia-led portfolio of businesses focused on structural growth markets. Prudential plc has 20 million customers (as of December 31, 2019) and is listed on stock exchanges in London, Hong Kong, Singapore and New York.

Prudential plc is not affiliated in any manner with Prudential Financial, Inc., nor with the Prudential Assurance Company, a subsidiary of M&G plc, a company incorporated in the United Kingdom.

AM Best downgrades, removes Foresters from ratings

AM Best has removed from under review with negative implications and downgraded the Financial Strength Rating to B+ (Good) from A- (Excellent) and the Long-Term Issuer Credit Rating to “bbb-“ from “a-” of Foresters Life Insurance and Annuity Company (FLIAC) (New York, NY).

The outlook assigned to these ratings (ratings) is negative. “Although FLIAC is fundamentally sound in terms of risk-adjusted capitalization and operating earnings, the rating downgrades reflect drag from Nassau’s insurance operating entities,” AM Best said in a release.

On July 1, 2020, Nassau Financial Group, L.P. (Nassau) announced that it had completed the acquisition of FLIAC from The Independent Order of Foresters. Concurrently, AM Best withdrew the ratings following its merger into Nassau Life Insurance Company.

The ratings reflect FLIAC’s balance sheet strength, which AM Best categorizes as adequate, as well as its adequate operating performance, limited business profile and appropriate enterprise risk management.

AM Best expects the earnings impact of the acquisition for Nassau to be modest in the near term, although accretive in the longer term assuming satisfactory execution of strategic plans.

Craig DeSanto named president of New York Life

New York Life’s board has elected Craig DeSanto as its president of the company, the New York Life reported this week. DeSanto, 43, had been co-Chief Operating Officer. New York Life chairman and CEO Ted Mathas had been president since former president John Y. Kim retired in 2018. DeSanto continues to report to Mathas.

As president, DeSanto will oversee all businesses of the company, including the Individual Life Insurance and Agency Distribution units, as well as Retail Annuities, New York Life Investment Management, and the company’s portfolio of strategic businesses.

DeSanto joined New York Life in 1997 as an actuarial intern, later becoming head of the Institutional Life Insurance business, Individual Life Insurance business, and Eagle Strategies. In 2015, he was appointed to lead the company’s Strategic Businesses, where he built businesses that support the company’s core retail life insurance franchise.

In 2017, DeSanto joined the company’s Executive Management Committee, and in the two subsequent years, he assumed oversight for Retail Annuities and New York Life Investment Management, respectively.

DeSanto helped lead New York Life’s pending acquisition of Cigna’s Group Life and Disability Insurance business, which is the company’s largest acquisition to date. The transaction is expected to close in the third quarter.

© 2020 RIJ Publishing LLC. All rights reserved.

Vanguard’s (recordkeeping) passage to India

Posted on July 24, 2020 by -

Conceding that its information systems are outdated—based on obsolete mainframe computers and decades-old software—Vanguard, the Valley Forge, PA-based $6.2 trillion financial services company, is transferring its retirement plan administration business to the Bengaluru, India-based tech giant, Infosys.

The Times of India reported the value of the recordkeeping business at $1.5 billion, with the value possibly rising to $2 billion over a 10-year period. Infosys beat Wipro Technologies for the contract, which was also pursued by Accenture and TCS, the news service said this week.

Infosys, founded in 1981 and listed on the New York Stock Exchange, has revenues of $12.7 billion, 239,000 employees, almost 1,500 IT customers in 46 countries. Its CEO since early 2018 has been Salil Parekh, an aeronautical engineering graduate of the Indian Institute of Technology with masters degrees in mechanical engineering and computer science from Cornell University.

According to the Vanguard website, “Infosys currently serves half of the top 20 retirement service firms in the U.S., helping clients to manage risk, improve participant experience, and deliver better retirement plan outcomes through business transformation, technology services, and digital solutions.

“The firm offers end-to-end, enterprise-wide insurance and retirement business-process solutions across five core businesses: life insurance and annuity services, producer services, retirement services, employer sponsored services, and functional BPO services.”

“Industry consolidation in recordkeeping has been a long-term trend,” said Tim Rouse, president of SPARK, the recordkeepers’ trade association, in an interview with RIJ. “If you look back ten years, the number of companies that still do their own recordkeeping is much lower. For example, Wells Fargo sold its recordkeeping business to Principal last year. The driver ultimately is cost savings.”

Infosys stock has risen from about $7 on March 13 to $12.55 on Tuesday. There’s been little or no mention of the potential for a culture clash or even financial clash between Vanguard, which operates like a cooperative and has never disclosed the precise financial relationship between its funds and its back-office operation, and a publicly held partner.

Comments by Vanguard Institutional Investor Group chief Martha King suggested that Vanguard would rather focus on its virtual advice capabilities and reduce the costs of recordkeeping, a low-margin business.

“Coupled with Vanguard’s increasing investment in advice capabilities and client experience, we will set a new bar for personalization, ease, and efficiency for sponsors and participants alike,” King said in a release.

Of Vanguard’s $6.2 billion of assets under management (AUM), $1.3 trillion is in its defined contribution business. It is the largest manager of defined contribution assets in the world, and a leading issuer of target-date funds and exchange-traded funds.

Over the past decade, as investors have flocked to low-cost index funds, a Vanguard specialty, the firm’s AUM has grown dramatically—with asset flows in some years surpassing the flows of the next nine largest asset managers in the U.S., according to Morningstar.

Approximately 1,300 Vanguard roles currently supporting the full-service recordkeeping client administration, operations, and technology functions will transition to Infosys. All Vanguard employees currently performing these roles will be offered comparable positions at Infosys in close proximity to Vanguard’s offices in Malvern, PA, Charlotte, NC, and Scottsdale, AZ.

Infosys will start this project with 300-400 employees in India and eventually increase to 3,000-4000 employees; Infosys has a plan to set up the facility in Electronics City in Bengaluru to service this deal.

© 2020 RIJ Publishing LLC. All rights reserved.

Wells Fargo’s New Annuity Wagon

Posted on July 24, 2020 by -

Imagine that you’re a 65-year-old participant in a 401(k) plan, preparing to retire. You’ve got $500,000 invested in a 2020 collective investment trust (CIT), which is similar to a 2020 target date fund. The manager of the CIT offers you this prepackaged retirement income strategy:

You’ll split your $500,000 into two parts. You’ll leave $425,000 in the 401(k) plan, and spend about $22,500 of it per year. With the other $75,000, you’ll buy a deferred income annuity that will start paying you about $18,000 a year if and when you reach age 85.

Meet the Wells Fargo Retirement Income Solution, which the brand-bruised, $2 trillion bank and asset management firm launched this spring. The firm is eager to grow its $12 billion target-date CIT business, and it believes that an income option will add cachet as well as new functionality.

“We did survey work at the participant and sponsor levels, and we heard a lot about the need for ‘liquidity’ and ‘flexibility,’” Nate Miles, head of retirement at Wells Fargo Asset Management, told RIJ in an interview. Participants need liquidity; and plan sponsors need the flexibility to change annuity providers if for any reason they need or decide to.

Many investment companies have tried, are trying, and will try to retrofit the tail end of a 401(k) plan to produce lifetime income for participants. They have to, or they risk losing access to trillions in tax-deferred money as baby-boomers age out of the “accumulation” stage and into the retirement spending (or “decumulation”) stage.

DCIO (Defined Contribution Investment Only) specialists like Wells Fargo are arguably not positioned as well as full-service retirement plan providers to control their own destinies. On the other hand, they offer “unbundled” a la carte solutions that some plan sponsors are said to prefer.

Nate Miles

With luck, elements of the 2018 SECURE Act will make plan sponsors more receptive to incorporating income solutions into plans. But the process is complicated—for many reasons. And, except in isolated areas, such as the academic market, neither plan participants nor plan sponsors are clamoring for this service.

Wells Fargo isn’t the mostly likely pioneer in the decumulation business. The company is still recovering from a multi-year “cross-selling” scandal that cost billions of dollars in refunds, fines and settlements, as well as a chunk of the firm’s reputation. As of 2019, it has a new president and CEO, Charles Scharf. Last year, Wells Fargo Bank sold its retirement plan business to Principal Financial for $1.2 billion. Now, boldly, it’s tackling the age-old “annuity puzzle.”

The DNA comes from SSgA

Wells Fargo Retirement Income Solution has its own particular nuances, but the company is not developing it entirely from scratch. For the two years ending in August 2016, Miles was head of U.S. Defined Contribution Investment Strategy at State Street Global Advisors (SSgA), where he worked on a similar target-date/deferred income annuity program.

As noted above, the actual design of the Wells Fargo Retirement Income Solution is pretty simple. (In fact, it resembles a strategy published by Jason S. Scott at Financial Engines over a decade ago.) Plan participants would be defaulted into an age-appropriate Wells Fargo target date CITs. As they approach retirement, they would learn about a packaged solution for their future income needs, combining a systematic withdrawal plan with an annuity.

A small portion (15%) of their CIT balance would be applied to the purchase of a QLAC or qualified longevity annuity contract. These are fixed deferred income annuities for qualified money, whose monthly payouts can be postponed until age 85. QLACs were created by the U.S. Treasury Department in 2014 to help retirees delay their annuity payments without running afoul of the requirement for minimum distributions (RMDs) from retirement accounts starting at age 72.

The remaining 85% of the retiree’s plan assets would remain in the Wells Fargo CIT. Wells Fargo would distribute it at the non-guaranteed rate of 5% a year. “We envision fees of 18 to 21 basis points on the money that stays in the plan,” Miles said. The recordkeeper will add an as-yet undetermined charge for running the systematic withdrawal plan. The cost of the annuity will be built into its payout rate.

Engaging the disengaged

Wells Fargo hopes to use the participants’ own inertia to carry them into the solution. People who have been invested for years in target date funds are characteristically passive. Wells Fargo is betting that when they reach age 65 and Wells Fargo offers them a packaged solution to their retirement income dilemma, a significant number of them will accept it.

“Our guess is that the auto-enrolled, auto-escalated participants are not engaged enough in the process to feel confident about choosing among many different retirement income options and strategies. We went back and forth on how much choice to offer,” Miles told RIJ. “We think that offering less choice, not more, is right for participants [who have consistently been passive investors].”

“From a marketing perspective, we would hope that our participants would be aware of the program from the beginning,” he said. “We would increase communications starting at age 60, and then have multiple points of communication as they approach age 65. We aren’t licensed to sell insurance, so the participants ages 65-plus would work with a representative of the insurance carrier [that issues the annuity].”

Still seeking partners

Wells Fargo Retirement Income Solutions is just getting started. It hasn’t formally engaged any life insurers who sell QLACs. Retail sales of all deferred income annuities in 2019, including QLACs, were $2.5 billion, or about one percent of total annuity sales. The “opt-in” aspect of the Wells Fargo plan also presents a potential pricing problem for annuity issuers.

Since participants aren’t defaulted into the annuity purchase, there’s a risk of “adverse selection.” That’s the risk, prevalent in the retail annuity space, that only the healthiest people—with above-average life expectancies—will opt-in. Insurers have to raise prices to compensate for that effect, which lowers the annuity payout rate and makes it less attractive.

In pitching the solution to plan sponsors, Wells Fargo stands to benefit from a provision in the 2018 SECURE Act that reduced the risk that plan sponsors might be sued for choosing an annuity provider that fails someday. “While assets leave the plan when annuity purchases occur, the money is still inside the plan when we’re asking the participant to choose the solution. So the plan sponsor could still benefit from the protections of the SECURE Act,” he said.

Miles also assures liability-conscious plan sponsors that Wells Fargo has a process for vetting and contracting life insurers. His firm will be acting as a fiduciary—a so-called “3(38)” fiduciary—in choosing the life insurer. “We’ll be taking responsibility for the selection of the insurance carrier,” he said. The selection process will be done by Wells Fargo’s Insurance Credit Analysis Group, which also evaluates annuity providers with products for sale via Wells Fargo Advisors’ 13,500 financial advisors.

Given his experience at SSgA, Miles appears to have few illusions about the difficulty of what he’s trying to accomplish—convincing multiple parties with dissimilar financial needs and imperatives to swim in the same direction.

“There are three or four sales here,” he told RIJ. “There’s the participant, the plan sponsor, the insurance carrier, and the recordkeeping platform. Each one of them requires time and thoughtful product development.”

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